June 2023
US Economy: Dueling narratives.
U.S. economic data continue to flash both positive and negative signals: In May, the labor market underscored strength by adding 339,000 new jobs while commercial real estate countered with rising office vacancies. Overall, capital markets suggest further cooling as rising interest rates trigger consumer credit delinquencies and bank lending continues to tighten, telltale signs of slowing economic activity.
US Stocks: Tech rules the roost.
Just 7 big tech stocks account for the entire 10% gain in the S&P 500 so far in 2023 and the reason the index finished positive in May. Boosting big tech is easing inflation and the promise of artificial intelligence, with AI companies like Nvidia (+36.3) and Alphabet (+14.5%) among the biggest beneficiaries. Beyond that, 8 out of 10 S&P 500 sectors lost ground in May, while the Dow was down 3.2% and the Russell 2000 (small stocks) lost 0.8%.
Foreign Stocks: Japan surprises.
Previously high-flying international stocks stumbled, with energy (-10.3%) one of the worst performing sectors amid signs of further economic weakness in Europe and China. Meanwhile, Japan posted a return of 1.9% on relatively robust manufacturing and services data. A rallying U.S. dollar detracted about 2% from returns as the greenback was somewhat counterintuitively sought as a safe-haven despite the U.S. debt ceiling standoff.
Fixed Income: Bond jitters.
The yield on 10-year U.S. Treasury bonds rose almost 0.4% in May before the debt ceiling standoff headed toward resolution. Generally, bond markets sold off with core bonds among the weakest performers, with the exception of emerging markets (EM) debt. EM debt benefitted from a stronger economic outlook compared to developed markets and less threat of tighter monetary policy and its associated headwinds.
Real Assets: Almost all negative.
Real assets continued to struggle in an environment less concerned with runaway inflation and more focused on economic weakness. While the housing market has demonstrated significant resiliency, sectors such as office real estate have born the brunt of what appears to be a secular change in occupancy and a weakening economy to boot. After a 6% decline in May, office REITs (Real Estate Investment Trusts) are down nearly 23% this year.
Alternatives: Illiquid opportunities.
Hedge fund strategies posted modestly negative results in May. Meanwhile, private credit continued to get squeezed by bank lending standards tightening to a degree we haven’t seen since the 2008 financial crisis, the lowest corporate bond issuance since 2011, and widening credit spreads. As a result, attractive opportunities may be materializing in the credit sector for investors willing to tolerate some illiquidity.
Source of data: Bloomberg
Equities Total Return
| MAY | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 0.4% | 9.6% | 2.9% |
| U.S. Small Cap | (0.9%) | (0.1%) | (4.7%) |
| U.S. Growth | 4.3% | 19.8% | 9.1% |
| U.S. Value | (3.8%) | (1.7%) | (5.0%) |
| Int’l Developed | (4.2%) | 6.8% | 3.1% |
| Emerging Markets | (1.7%) | 1.1% | (8.5%) |
Fixed Income Total Return
| MAY | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (1.1%) | 2.5% | (2.1%) |
| TIPS | (1.2%) | 2.2% | (4.2%) |
| U.S. High Yield | (0.9%) | 3.7% | (0.2%) |
| Int’l Developed | (0.3%) | 1.9% | (4.8%) |
| Emerging Markets | 0.7% | 3.4% | 5.4% |
| Tax-Exempt | |||
| Intermediate Munis | (0.9%) | 0.6% | 0.5% |
| Munis Broad Mkt | (0.8%) | 1.9% | 0.2% |
Non-Traditional Assets Total Return
| MAY | YTD | 1 YR | |
|---|---|---|---|
| Commodities | (5.6%) | (11.4%) | (22.5%) |
| REITs | (4.2%) | (2.3%) | (15.7%) |
| Infrastructure | (5.5%) | 0.8% | (6.7%) |
| Hedge Funds | |||
| Absolute Return | (0.5%) | (0.5%) | 0.2% |
| Overall HF Market | (0.3%) | 0.0% | (1.2%) |
| Managed Futures | 2.7% | (0.6%) | (0.6%) |
Economic Indicators
| MAY-23 | NOV-22 | MAY-22 | |
|---|---|---|---|
| Equity Volatility | 17.9 | 20.6 | 26.2 |
| Implied Inflation | 2.2% | 2.4% | 2.7% |
| Gold Spot $/OZ | $1963 | $1769 | $1837 |
| Oil ($/BBL) | $73 | $85 | $123 |
| U.S. Dollar Index | 120.9 | 123.5 | 118.1 |
Our Take
With the U.S. debt ceiling compromise signed into law, a major headwind has been removed from the markets, albeit not permanently, as Congress has basically kicked the can down the road. At this point, it is likely that investors will revert to wringing their collective hands over recession brought on by higher interest rates.
A trend we have seen in the past several months is the bond market seeming to suggest more downside for the economy and the markets, even as stocks continue to sail along. This was true during the worst of the debt ceiling angst, when yields on Treasury notes maturing in June spiked 0.8% before a debt deal was reached, whereas equity volatility remained on balance lower than the month prior.
Are equity investors really that much more optimistic relative to their fixed-income peers? Looking beyond the headline numbers, the answer is likely no: The S&P 500 Index, a market cap weighted measure of US large-cap stock performance, was essentially flat in May, managing a price return of about 0.3%.
Look beyond the headline number, however, and you’ll see strong divergence. The average S&P 500 performance in May (not weighted by market value) was actually a drop of close to 4%. And just a quarter of the S&P 500 stocks are outperforming the index so far this year, a 50-year low if this trend continues through the end of 2023. Driving the disparity in performance is generally fearful investor sentiment, which is favoring a handful of mega-tech stocks with resilient earnings and idiosyncratic growth, such Amazon, Microsoft, Nvidia and Alphabet. For upward momentum to be sustainable, however, stock market leadership needs to expand beyond a dozen or so firms.
What might markets be worried about?
Except for the incredibly robust May jobs report, a bevy of data points toward recession. What is probably most troubling is the deterioration in U.S. consumer spending. We are seeing consumers spend less at restaurants, a trend since the beginning of 2022, coupled with slowing automobile purchases and rising auto loan delinquencies, as the overall U.S. savings rate (5.4%) has fallen to its lowest point in a decade.
Furthermore, May marked the 13th sequential decline in the Conference Board’s Leading Indicators series. This is the third-longest downward streak, after the 22 months during the 1973-1975 recession and the two-year streak leading up to and through the Great Financial Crisis in 2008. We are also monitoring developments in the banking sector as the crisis that began in March continues to simmer on the back burner. Reduced credit availability due to tighter lending standards, higher interest rates, and risk-aversion will likely continue to be a headwind for both consumers and businesses.
Considering the backdrop of uncertainty year-to-date, and five-months after one of the worst years for diversified portfolios in modern history, portfolio results this year have been reasonably solid. We believe our client portfolios remain well-positioned to meet long-term objectives, even if a recession manifests. In the near term, the reduction in credit availability via banks and the corporate debt markets may lead to focused opportunities in private lending or distressed real estate debt for investors willing to establish strategic, likely less-liquid positions.
